Foreclosure: How to avoid it and what to do after

Your mortgage lender can take your home and sell it if you don’t make your mortgage payments.

Elissa

Elissa Suh

Published February 3, 2020

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KEY TAKEAWAYS

  • How the foreclosure process works varies by state — it may happen through the court system

  • Borrowers in default will be notified and warned by the lender in advance of a foreclosure action

  • People facing foreclosure can still find a way to avoid it or even save their homes

  • Foreclosed homes for sale might be cheaper, but you may not have time to scrutinize the property

If you stop paying your mortgage, your home will eventually go into foreclosure. That means the mortgage lender has the right to seize your home, kick you out, and sell the home to recoup its losses.

Foreclosure is a painful process. It can involve a visit from the sheriff to physically evict you from your home, whether you’ve packed your bags and collected your belongings or not. In addition to losing your home, you’ll lose all the money you’ve put into that real estate as an investment, and have a negative mark on your credit history that will last for years. Fortunately, there are a few ways to avoid foreclosure, like asking the lender for a loan modification or having a short sale.

Buying foreclosed homes, which usually end up sold at auction, can be a good real estate investment. However, there are some drawbacks because the auction part of the foreclosure process tends to move very quickly. We’ll discuss how foreclosure works as well as different foreclosure prevention methods.

In this article:

How does foreclosure work?

Foreclosure happens when you’ve become delinquent on your mortgage payments. You’re considered delinquent after missing your first mortgage payment, but you usually have time to catch up. However, if you keep neglecting to pay the unpaid loan debt and the upcoming monthly payments, then you’ll be considered to be in default. Borrowers may receive notices throughout this time, letting them know they could be facing a foreclosure action. You might be notified after 30 days or you might receive a notice along with your first missed payment. The exact timeline regarding the foreclosure proceeding depends on your state laws.

Half of the states have judicial foreclosure and the other half have nonjudicial foreclosure process. With judicial foreclosure, the mortgage company must file a court order to be able to foreclose on the home and ultimately sell it. The borrower usually has to appear for a hearing. In nonjudicial foreclosure, the mortgage lender doesn’t need to make a foreclosure filing with the court. Also called a power of sale or statutory foreclosure, this type of foreclosure proceeding often happens faster since the court isn’t involved. If you go through a nonjudicial foreclosure proceeding, the mortgage lender will specify and include the details of how it would work in your loan agreement.

Regardless of your state law, the process remains similar overall. The lender will file a foreclosure documents (known as notice of default, notice of sale, or lis pendens) at the county recorder’s office. A more public foreclosure notice (like a sign outside your house) may also be required.

During the foreclosure process the borrower is typically given a window of a time, called a redemption period, to pay off all their debts to stop the auction from happening. If they fail to do so, the property will be sold at public auction overseen by someone appointed by the court or someone appointed by the mortgage company called a trustee.

Once the property has been sold, the proceeds will be used to pay the mortgage holder, like the bank, and pay off any other lienholders. Mortgage payments consist of more than just the principal loan and interest — there’s also mortgage insurance and property taxes and if you haven’t been paying the latter as a consequence of missing mortgage payments, then you may have may have a tax lien against you. The IRS itself can foreclose on your home (tax foreclosure). A lien is the first step, which then becomes a levy.

During the foreclosure process, you may also be offered cash for keys to leave the property by a specified date.

How does foreclosure affect you?

Foreclosure has many consequences. It’s possible that you may be evicted or forced out of your home, which can be an emotionally disruptive experience, especially if you have any children.

Missed mortgage payments can lower your credit score and foreclosure stays on your credit report for up to seven years, making it difficult to take out a new mortgage, a car loan or credit card.

The IRS views some forms of cancelled debt as income for tax purposes, which means the remaining value of your mortgage loan can be counted as taxable income. Talk with a tax attorney for more information.

(If your house was foreclosed on during 2007 and 2017, up to $2 million of forgiven debt can be excluded from your taxable income, thanks to the Mortgage Debt Relief Act.)

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How to avoid foreclosure

The first thing you should do if you think you’re going to miss a mortgage payment is to call your loan servicer as soon as possible. They’ll steer you in the right direction and some may even ask that you attend foreclosure prevention counseling. Remember that your mortgage lender doesn’t want to seize your home, as it can cost them time and money — they would prefer you to keep the house and make your monthly mortgage payments.

1. Ask for loan modification

Loan modification is changing the terms of your loan, whether it’s the interest rate, the principal, or the loan term. Loan modifications are usually offered to people who are suffering financial hardships after major life changes, like getting laid off from a job or losing a spouse’s income stream.

Loan modification makes your payments more affordable, but you might owe more money over a longer period of time. With this foreclosure prevention method, you would also get to keep your home as long as you keep making the lower payments.

You can have an attorney negotiate the terms with your lender or get assistance from Flex Modification program if you have a loan from Freddie Mac or Fannie Mae or the FHA National Servicing Center if you have an FHA loan.

Prior to 2017, the federal government’s own Making Home Affordable Modification Program (HAMP) helped people modify their mortgage loan after they demonstrated during a trial period that they would be able to make monthly payments.

2. Forbearance

Forbearance means that you stop making payments for an agreed-upon period of time. If your lender lets you choose forbearance instead of foreclosure, you’ll have extra time to gather your cash to make both delinquent mortgage payments as well as current payments. If your loan servicer doesn’t think you’ll be able to make current payments after the forbearance period, they might not allow it.

3. Get a deed in lieu of foreclosure

The borrower effectively relinquishes ownership over their house by giving the lender the deed of trust in exchange for mortgage relief. You may also have to make some payments toward the remaining mortgage balance.

A deed in lieu of foreclosure is effectively a foreclosure without most of the negative consequences of foreclosure. You get to leave the home on your terms (usually without a sheriff coming to evict you) and your credit won’t be affected as badly.

4. Have a short sale

In a short sale, the property owner voluntarily sells their home, usually below the market rate. The lender accepts the proceeds from the sale, which are typically short of the actual loan balance, and forgives the remaining mortgage debt.

5. File for Chapter 13 bankruptcy

Bankruptcy is one of the more severe options you can choose, but it will help you stay in your home. If a court allows you to declare bankruptcy, it may put you on a repayment plan that allows you to make payments against the delinquent amount as long as you keep up with your current mortgage payments.

Note that in most cases, you must declare Chapter 13 bankruptcy if you want to keep your property. Declaring Chapter 7 bankruptcy doesn’t involve creating a repayment plan and could mean selling your home anyway.

Filing for bankruptcy can make it more difficult to take out a mortgage in the future. Learn more about getting a mortgage after bankruptcy.

6. Beware of foreclosure relief scams

Sometimes, you’ll receive notices from people other than the loan servicer who promise to help you pay your mortgage and avoid foreclosure. Shred these notices as soon as possible. Many times, these people use publicly available information about your loan to offer mortgage relief. But this is false; most of these schemes either involve transferring your home to the scammer in return for a large loan (that you still have to pay back), or charging fees and giving you nothing in return.

In the end, after paying money to the scammer you may still risk foreclosure. When you receive a notice from someone other than your lender or government, call your mortgage lender right away to make sure it’s accurate. The so-called services offered by the foreclosure scammers are usually offered free of charge by your lender.

Buying foreclosure homes

If you’re shopping for a home, you may find deals on homes that have been foreclosed on. But not every foreclosed home is a good deal, and some may not be on sale at all. "Pre-foreclosure homes" are just what they sound like — homes that have not actually been foreclosed on yet.

Homes that are actually foreclosed (also called bank-owned homes or real estate-owned (REO) homes) may be very affordable. You’ll likely see listings for below-market-rate prices, especially if the lender is trying to sell quickly. In some cases, you may have to pay in cash for a foreclosed home. Additionally, foreclosure homes selling at auction can move quickly, so you might not be able to conduct an appraisal, inspect the house, or see the house at all.

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